Selling stocks amid a stock market downturn isn’t likely to be your preference, but it might be worthwhile if circumstances call for it. The silver lining is that while you might end up taking a loss on your position, it’s not a guarantee. Plus, there are potential investment and tax benefits to be had.
Let’s review the reasons selling stocks in a bear market can make a ton of sense.
1. You need the money
If you need money to cover an unexpected expense, your stock portfolio is there for the taking. Naturally, no investor wants to sell stocks after they’ve declined in value, but reality might call for some early liquidation if you aren’t otherwise prepared. It’s probably not the financially optimal choice, but it may very well be the necessary one.
Since you might have to sell stocks at a loss in this scenario, it’s helpful to look at the actions that could prevent unwanted selling in the future. First, having a fully liquid, cash emergency fund is an imperative for all investors, especially because we don’t know how long this bear market will last and we also don’t know when the next one will occur.
Next, be sure to practice portfolio diversification. A portfolio comprised of all stocks can easily lead to outsized volatility or force you to sell at inopportune times. Consider spreading your money around in different asset classes and different global markets to ensure you aren’t too reliant on any one thing going your way.
2. You want to minimize taxes
People with large concentrated stock positions are often hesitant to liquidate their shares due to large impending capital gains taxes. A bear market presents an opportunity to exit stock positions at smaller gains, which leads to smaller tax bills.
Let’s take a look at a brief example of how this works in practice.
Say you had $50,000 worth of a stock in January, but the value has declined to $40,000 as of this writing. Assume your cost basis in the stock is $10,000, all of the gains are long-term, and you face a 15% long-term capital gains tax rate.
If you were to sell the position in January, you’d incur taxes of $6,000 (($50,000-$10,000) * 15% = $6,000).
If you were to sell the position today, you’d be liable for taxes of $4,500 (($40,000-$10,000) * 15% = $4,500).
Even though you’d end up with less money overall if you were to sell now, you’d at least benefit from a lower tax burden.
3. You want to reposition into index funds
Maintaining a diversified portfolio is critical when it comes to managing your investments. Single stock positions contain “company-specific” or “idiosyncratic” risk, which has the potential to increase portfolio volatility. Higher volatility in the long run often leads to subpar investment returns.
If you’re curious about index funds, bear markets provide both a sensible departure point from existing positions and a smart entry point for those taking a long-term approach. Over periods of many years, bear markets reveal themselves to be valuable moments of repositioning, during which you can exit risky positions and enter better ones at a smart time.
Exiting single stocks at a minimized tax loss and repositioning your money into well-diversified, low-cost index funds can make a lot of sense as a long-term play. With this strategy, you have the chance to exit gracefully from your previous position, while at the same time gain the opportunity to begin anew with a more balanced approach.
Selling can help in certain ways
Of course, it would be great to be able to buy at the bottom and sell at the top with perfect precision. Because this isn’t possible, we have to make the most of what we’re given and determine the best course forward given our current variable set. Bear markets can and do present opportunities, so it’s smart to know how to make the most of market downturns and manage your portfolio accordingly.
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